Accounting for Inventory

[wsbjr]

Under Rev. Proc. 2001-10 a small company that keeps and inventory is allowed to use the cash method. Can anyone tell me how the company using this method should account for inventory purchases and COGS during the year?

[BOB W]

You......

...... still have to account for goods not sold (inventory). I treat Sales through gross profit just like accrual basis. With an inventory type business it just makes sense. I mark the return as a "hybrid". Other non-COGS are treated on a cash basis.

[Brad Imsdahl]

TTB, page 8-13 under Author's Comment says this: "Even if an exception to the accrual method of accounting applies, the taxpayer must keep inventories to clearly show income. The cost of goods sold calculation must be figured under the cash method as well as the accrual method. The only difference between accrual and cash for inventory purposes is the timing of recognizing income on the accounts receivable. Accounts receivable for a cash method taxpayer is not recognized until actual payment is received. The cost of selling the goods is not deductible until income is recognized under the cash method, even if the goods were actually paid for in a prior tax year."

[wsbjr]

Accounting for Inventory

TTB, page 8-13 under Author's Comment says this: "Even if an exception to the accrual method of accounting applies, the taxpayer must keep inventories to clearly show income. The cost of goods sold calculation must be figured under the cash method as well as the accrual method. The only difference between accrual and cash for inventory purposes is the timing of recognizing income on the accounts receivable. Accounts receivable for a cash method taxpayer is not recognized until actual payment is received. The cost of selling the goods is not deductible until income is recognized under the cash method, even if the goods were actually paid for in a prior tax year."

Brad
I did see this Author's Comment. However, I still am a bit confused on how one figures COGS under the cash method. Are inventory purchases simply charged to COGS when purchased and later allocated to inventory at the end of the accounting period when an inventory is taken?

[JoshinNC]

Here's how I do it (not saying it's correct)

COGS =

Beginning inventory + purchases during year + cost of labor + direct expenses - ending inventory = cash method COGS

[thomtax]

Sounds

right to me.

LT

[geekgirldany]

I've got a customer that I do this for. Inventory is still shown even though they are on cash basis. I just put in a adjustment in their materials to account for the inventory at the end of the year.

[Brad Imsdahl]

I've got a customer that I do this for. Inventory is still shown even though they are on cash basis. I just put in a adjustment in their materials to account for the inventory at the end of the year.

Actually, that is not the correct way to do it. TTB, page 5-12 under "Did You Know? If the cash method of accounting is allowed, inventory items must still be reported on Part III of Schedule C, rather than as materials and supplies on line 22. The cost of inventory items under the cash method of accounting is deductible in the later of:
- The year the inventory is sold, or
- The year the inventory is paid for."

However, I still am a bit confused on how one figures COGS under the cash method. Are inventory purchases simply charged to COGS when purchased and later allocated to inventory at the end of the accounting period when an inventory is taken?

COGS is simply calculated using the cash method...meaning everything identical except for AR and AP. In other words, do your normal COGS calculation. Then pull out any income that is AR, and pull out any cost of sale that has not yet been paid for.

[Brad Imsdahl]

COGS is simply calculated using the cash method...meaning everything identical except for AR and AP. In other words, do your normal COGS calculation. Then pull out any income that is AR, and pull out any cost of sale that has not yet been paid for.

If I were doing the bookkeeping for the business, I would keep the books under a hybrid system; Accrual for inventory purchases and sales, and cash for all service type income and expenses.

Then on December 31, I would simply subtract AR from gross sales, and add AP to ending inventory for the income statement being reported on the tax return. On January 1 of the next year, I would simply reverse those two entries in the books and continue to use the hybrid system for the rest of the year. Then do the same adjustment at the end of the year for the tax return, and reverse the entry at the start of the next year, and so on...

[Joe Btfsplk]

It is the end result that counts

Whether you call it materials, supplies, purchases or cost of sales when you buy the inventory items, you need to end up with the ending inventory EXCLUDED from cost of sales.

I've never considered the possibility that a cash-basis taxpayer might have some items in inventory that would be in Accounts Payable if he were on the accrual basis. Theoretically, those items should perhaps be excluded until paid for. In real life, no one is likely to make that kind of hair-splitting distinction.

Such items, if ignored, would not be in either the beginning or ending inventory, so it would have a 'deminimis' effect.

[BOB W]

Guys/Gals....

..... It is so much easier going the "Hybrid" method (Accrual for Sales >COGS). This eliminates having to make any crazy adjustments.

You can have Cash Basis accounting and make an AR and AP adjustment at the end of each period. And an inventory/Ending Inventory adjustment and you are done.

[OldJack]

The cost of selling the goods is not deductible until income is recognized under the cash method, even if the goods were actually paid for in a prior tax year."

Well... there you go again.. saying never say never in reverse.

Truth is some small businesses operate with inventory items as a minor factor of the business and as such are not really required to maintain accounting for such minor inventory in order to clearly show income. I believe it falls under the IRS's wording of "de minimis" amounts. ie: I don't know maybe the cost of a carpenters bucket of nails?

[Brad Imsdahl]

And I wasn't talking about materials and supplies that are de minimus and would not fall under inventory rules. I was talking about taxpayers who clearly DO have inventory, but are not required to use accrual under one of the exceptions.

[Davc]

If I were doing the bookkeeping for the business, I would keep the books under a hybrid system; Accrual for inventory purchases and sales, and cash for all service type income and expenses.

Then on December 31, I would simply subtract AR from gross sales, and add AP to ending inventory for the income statement being reported on the tax return. On January 1 of the next year, I would simply reverse those two entries in the books and continue to use the hybrid system for the rest of the year. Then do the same adjustment at the end of the year for the tax return, and reverse the entry at the start of the next year, and so on...

The adjustments to arrive at cash basis are based on the increase or decrease of A/R and A/P. Not on year end totals.

[Brad Imsdahl]

The adjustments to arrive at cash basis are based on the increase or decrease of A/R and A/P. Not on year end totals.

Same thing.

Doing a once per year adjustment to get rid of AR and AP at the end of the year, and then putting it back into the books the next day on the first of the following year will produce the same result as making on going adjustments to AR and AP to arrive at cash basis.