Schedule C - Inventory Cost

[Racheal]

Hi, All.....!

I have a client who is a sole proprietor who owned a Hispanic retail store. In a previous return, their accounting method was "CASH" and all of their purchases have been paid in full upon receipt of inventory - no accrual. As a result, their return showed all inventories paid was expensed for that year as COGS regardless of whether the inventory had been sold. Is this correct?

thank you for your time.

Racheal

[myerstaxes]

No this is not the proper way

This is the one part of the Schedule C where a hybrid method is allowed and most accurately reflects the income and expenses...I am sure he had inventory on the shelves for which are not sold at the end of the year...The inventory sold most accurately reflects the income reported in the tax year as is the expense of that inventory as Cost of Goods Sold...IRS views a business where the sale of goods is material, must use the COGS method of reporting the costs associated on the accrual method...
Go to Pub 334 for more information...page 12 explains this...

[Bees Knees]

TTB, page 8-13:

Inventory
An inventory is necessary to clearly show income when the production,
purchase, or sale of merchandise is an income-producing
factor. If a taxpayer must account for an inventory, the accrual
method of accounting must be used, unless one of the exceptions
applies. See Exceptions to the Accrual Method Rule for Inventory on
page 8-22.

Author’s Comment: 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 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.

TTB, page 8-22:

Exceptions to the Accrual Method Rule for Inventory
If a business produces, purchases, or sells merchandise, the business
must keep an inventory and use the accrual method for sales
and purchases. The accrual method for businesses with inventory
is not required under certain rules. The following businesses can
use the cash method of accounting, even if they have inventory:
1) The taxpayer has average annual gross receipts of $1 million or
less for each tax year since 1998, and the taxpayer is not a tax
shelter (Rev. Proc. 2001-10)...

So in other words, you do not need to use a hybrid method. You can still use cash if gross receipts are under a million. But you still need to keep inventory and figure cost of goods sold, even under the cash method. The only difference is you don't have to mess with accounts receivable and accounts payable like you would under accrual or hybrid.