Inventory

[Gretel]

I am somewhat confused. Client, cash basis, is in financial disaster for some years. Outstanding bills for inventory items (inventory was never used correctly in QB, so I have to do pretty much all calculations from scratch) are $20,000. Physical inventory count $10,000.
Since only checks are included in expenses and COGS, I assume I have to add $10,000 as COGS?

And then next year I have to back out whatever they paid as COGS?

Normally one deducts COGS at the later of when sold or paid for. But that assumes all COGS bills are entered into QB.

[Snaggletooth]

Cost of Sales

Gabriele, I believe the "canned" version of a cash-basis merchandising company in QuickBooks is altering the proper treatment of inventory and Cost of Sales.

No merchandising company theoretically should be expensing inventory to Cost of Sales, even if it's on the cash basis. But I believe the IRS allows them to do so if they are sufficiently small. So I would have to know more to suggest how to handle their taxes.

The proper way to report Cost of Sales for tax purposes is on Page 2 of the entity - whether it is a schedule C, 1120, 1065, or 1120S. The calculation differs from the accounting treatment in QuickBooks, and I think this is what is creating the confusion.

[rgtaxservice]

Small Taxpayer Exception

Under Rev Proc. 2001-10 Sect 4.
Taxpayers will revenues under $1,000,000 are not required to track inventory and can expense those items as COGS.
All you need to report are those bills that are paid. Beginning and ending inv balances are zero. You report the purchases or materials/supplies.

Method is other - I always attachment a statement to the return making reference to the Rev Proc.

[Jesse]

But wouldn't you have to account for an ending inventory even under the cash method? Your COGS is what you actually paid for and not accrued?

[JON]

The exception

is for the accrual method of accounting. The procedure is you do not have to account for receivables or payables. You do count inventory and their suggestion is you call it prepaid supplies/inventory. Remember inventory may not be deducted until the LATER of the date SOLD or Paid under the cash method. You have that right. If sales are more tha $1 mil and less than $5 mil you can not flink the NAICS tests which include wholesalers and retailers.

Out of accrual accounting does not mean you are out of inventory accounting!!!!!

[Gretel]

Gabriele, I believe the "canned" version of a cash-basis merchandising company in QuickBooks is altering the proper treatment of inventory and Cost of Sales.

No merchandising company theoretically should be expensing inventory to Cost of Sales, even if it's on the cash basis. But I believe the IRS allows them to do so if they are sufficiently small. So I would have to know more to suggest how to handle their taxes.

The proper way to report Cost of Sales for tax purposes is on Page 2 of the entity - whether it is a schedule C, 1120, 1065, or 1120S. The calculation differs from the accounting treatment in QuickBooks, and I think this is what is creating the confusion.

Ron, the problem is a TOTALLY messed up QB file. Until this year I didn't even realize how messed up the file is and tried to do the best with what was available. Now I realize I cannot take anything from that file beside the check register with payments and deposits.
So, the physical inventory count is $10,000, unpaid bills for inventory items are $20,000. Since they are not paid they do not count as COGS. Obviously they have sold $10,000 worth of COGS but don't get the deduction since the bills weren't paid.

The ending inventory is what is so confusing. $10,000 ending inventory will reduce their COGS but the expense wasn't accounted for in the first place.

Any thoughts are appreciated. Thanks.

[JON]

Was it

if the accounts payable inventory is not included in the CGS then you subtract only ending inventory from the CGS. If the A/P inventory is included in the CGS then you subtract both of the items from CGS. Unless you are amending previous years then that will change.

[Black Bart]

Interesting thread, eh? We've got some sharp guys here.

is for the accrual method of accounting. The procedure is you do not have to account for receivables or payables. You do count inventory and their suggestion is you call it prepaid supplies/inventory. Remember inventory may not be deducted until the LATER of the date SOLD or Paid under the cash method. You have that right. If sales are more tha $1 mil and less than $5 mil you can not flink the NAICS tests which include wholesalers and retailers.

Out of accrual accounting does not mean you are out of inventory accounting!!!!!

Please excuse the question, but it's been a long time since any of my clients had a real accounting problem. Okay, you're saying that right now Gabriele should make a journal entry and debit an asset account (either prepaid supplies or inventory) for the unpaid $10K merchandise and then she'd have to credit accounts payable for it even if her client is on the cash basis? Nothing else you can do, is there? Hmmm, lemme see now; this situation is like that Tom Hanks movie in which he says "There's no crying in baseball;" so I guess my question is "Is there any accrual in cash accounting?"

About your statement "you can not flunk the NAICS test;" is that the rule that says everybody is subject to real-world inventory rules and can't deduct unpaid merchandise no matter how much or how little the sales figures are?

[veritas]

Gabriele

Why don't you just use what was paid for the year and adjust for the increase or decrease in the difference in cost between the opening and ending inventory?

By the way in a class some years ago we were instructed for a cash basis taxpayer to not use the cost of goods section on the tax return, but rather to use an expense category.

[Black Bart]

I've read about this, but

Under Rev Proc. 2001-10 Sect 4.
Taxpayers will revenues under $1,000,000 are not required to track inventory and can expense those items as COGS.
All you need to report are those bills that are paid. Beginning and ending inv balances are zero. You report the purchases or materials/supplies.

Method is other - I always attachment a statement to the return making reference to the Rev Proc.

I never actually knew anybody that used it -- there just seems to be too much accountant in most accountants to completely ignore inventory unless it's just a very small amount. On a few clients with less than $500 merchandise, I've expensed it and listed zero beginning and ending inventories, although I still marked the "cost" box on the back of Schedule C.

How long have you used it? Any problems with IRS? Been audited more than usual? Why did you start using it? Do you have friends also using it? Any other items of interest?

And that's all I have to ask about that.

[Black Bart]

Say Gabriele,

I didn't exactly mean to take over your post discussing other things. Please excuse me. Did you ever get the answer you were looking for or do you still have questions about how to handle it? I don't have Quickbooks, so I don't know about that.

[Gretel]

"I didn't exactly mean to take over your post discussing other things. Please excuse me. Did you ever get the answer you were looking for or do you still have questions about how to handle it? I don't have Quickbooks, so I don't know about that."

Bart, I appreciate your comments. As long as I find answers I don't care who take over what. I kind of get the feel for the situation and what the knot in my brain is all about. See below.

"Why don't you just use what was paid for the year and adjust for the increase or decrease in the difference in cost between the opening and ending inventory?"

Thank you, Veritas. This is exactly what I came up with. Somehow, in my brain, the ending inventory was part of the bills that were not paid yet. All the posts somehow helped me to see that the ending inventory is somehow disconnected from bills paid or unpaid. Meaning I just have to account for inventory change since bills are neither on the books nor paid. I still don't really understand but I have a notion that this is the correct way.

"By the way in a class some years ago we were instructed for a cash basis taxpayer to not use the cost of goods section on the tax return, but rather to use an expense category."

That is interesting. I always thought of these "expenses" as COGS.

if the accounts payable inventory is not included in the CGS then you subtract only ending inventory from the CGS. If the A/P inventory is included in the CGS then you subtract both of the items from CGS. Unless you are amending previous years then that will change.

Thank you, Jon. I just can follow this rule and stop to try to grasp this in my situation. In normal situations it makes sense. But the huge amount of unpaid bills in comparison to ending inventory created a knot in my head.

It's so good to have this board to be surgeons for such knots. In general I understand inventory for cash basis taxpayers as no different than for accrual basis taxpayers.

[JAinNC]

Inventory can be so messy

That's why if I setup an accounting client who is a cash basis TP and there is inventory I start them out as "hybrid" so I can treat income as cash and COGS as accrual (with an accounts payable). That makes it easier.