Accrual Based Accounting - Inventory PO question

[midwaykid]

What is the name of your state? California

I'm an online seller of merchandise I purchase from China and sell online . When trying to figure out my COGS do I input the expense of the purchases when I receive the invoice from my supplier or when I actually pay it and receive the merchandise.

Example: I put in an order of product A in November 2018 and I paid a 30% deposit. In early January '19 I paid the remaining 70% balance and received the product shortly thereafter.


As I understand it, under accrual-based accounting you have to account for expenses as soon as they are incurred. Thanks in advance.

 

[adjusterjack]

If your annual gross receipts have been $25 million or less for the 3 prior tax years and you are not a tax shelter then you must use cash based accounting, not accrual.

See instruction for Schedule C:

https://www.irs.gov/pub/irs-pdf/i1040sc.pdf

 

[midwaykid]

Thanks for your reply, since i have inventory don't i need to use the accrual method?

 

[Taxing Matters]

If you keep an inventory then you must use an inventory accounting system. Inventory accounting is distinct from the issue of whether you use accrual vs. cash accounting for income and expenses other than inventory. If your business is a small business then you have an option to elect not to keep an inventory, but your accounting for the goods must still clearly reflect income.

Under inventory accounting, your costs for your inventory is accounted for as you sell that inventory. If the inventory is a lot of things that are the same kind of item then you would typically use a convention like first in, first out (FIFO) or last in, first out (LIFO). Is 2018 the first year of your business? If so, then how you file for 2018 is critical because the inventory accounting method you adopt when you file your return is the method you must use in future years. In order to change it later may require seeking consent from the IRS. LIFO often provides the best tax results for most sellers, but to use it you need to complete Form 970. If this is not the first return you are filing with an inventory you may have a problem because you may need to get approval from the IRS to change your method of accounting to fix any mistakes you've made in how you account for your inventory. See IRS Publication 538, which discusses methods of accounting. Inventory accounting is discussed starting on page 13. Remember, inventory accounting is distinct from the issue of whether you use cash or accrual accounting for things other than inventory.

I'd strongly recommend you get advice from a tax attorney or other tax professional who is familiar with the inventory accounting rules. People who primarily prepare 1040 forms are not likely to have the knowledge you need. It is very important that you pick the right accounting method because the choice can have a significant impact on the tax you pay, and which methods you are eligible to use and which of those will be best for you will depend on the details of your business. There is a lot to this and it not something you can easily sort out in an internet message board forum.

 

[LdiJ]

If you keep an inventory then you must use an inventory accounting system. Inventory accounting is distinct from the issue of whether you use accrual vs. cash accounting for income and expenses other than inventory. If your business is a small business then you have an option to elect not to keep an inventory, but your accounting for the goods must still clearly reflect income.

Under inventory accounting, your costs for your inventory is accounted for as you sell that inventory. If the inventory is a lot of things that are the same kind of item then you would typically use a convention like first in, first out (FIFO) or last in, first out (LIFO). Is 2018 the first year of your business? If so, then how you file for 2018 is critical because the inventory accounting method you adopt when you file your return is the method you must use in future years. In order to change it later may require seeking consent from the IRS. LIFO often provides the best tax results for most sellers, but to use it you need to complete Form 970. If this is not the first return you are filing with an inventory you may have a problem because you may need to get approval from the IRS to change your method of accounting to fix any mistakes you've made in how you account for your inventory. See IRS Publication 538, which discusses methods of accounting. Inventory accounting is discussed starting on page 13. Remember, inventory accounting is distinct from the issue of whether you use cash or accrual accounting for things other than inventory.

I'd strongly recommend you get advice from a tax attorney or other tax professional who is familiar with the inventory accounting rules. People who primarily prepare 1040 forms are not likely to have the knowledge you need. It is very important that you pick the right accounting method because the choice can have a significant impact on the tax you pay, and which methods you are eligible to use and which of those will be best for you will depend on the details of your business. There is a lot to this and it not something you can easily sort out in an internet message board forum.

Some of us who prepare 1040s do actually have an accounting background. I suspect that many people with accounting backgrounds would know more about inventory accounting than most tax attorneys.

 

[Taxing Matters]

Some of us who prepare 1040s do actually have an accounting background. I suspect that many people with accounting backgrounds would know more about inventory accounting than most tax attorneys.

However, most people who primarily prepare form 1040 returns are not accountants and do not have much experience with inventory accounting. It's not a criticism, it's just not something they see much. Hence my recommendation to the OP that he/she seek out someone who is familiar with those rules and not just go to anyone at, say, one of those big chain tax prep places for help. That's not to say those places wouldn't have someone who really knows the area, but the OP should ask the people he intends to consult specifically about their knowledge of the area before relying on them.

 

[davew9128]

As it so happens, one of my clients imports merchandise from China and sells it on Amazon. One of the problems I run into every year is that neither the internal accountant nor the outside bookkeeper understands how to properly book COGS and inventory. The recurring problem is that they book the purchase order into purchases for inventory when it is paid, not when the merchandise is received later so if the receipt of merchandise occurs after the end of the year, COGS will be artificially high, because the PO should have been booked as an other current asset instead of inventory.

That being said, under TCJA inventory can now be expensed, even though I am not converting anyone to that method.

By way of reference I'm an EA and waiting on results of the USTCP exam, without a true accounting background.

 

[LdiJ]

As it so happens, one of my clients imports merchandise from China and sells it on Amazon. One of the problems I run into every year is that neither the internal accountant nor the outside bookkeeper understands how to properly book COGS and inventory. The recurring problem is that they book the purchase order into purchases for inventory when it is paid, not when the merchandise is received later so if the receipt of merchandise occurs after the end of the year, COGS will be artificially high, because the PO should have been booked as an other current asset instead of inventory.

That being said, under TCJA inventory can now be expensed, even though I am not converting anyone to that method.

By way of reference I'm an EA and waiting on results of the USTCP exam, without a true accounting background.

I have an extensive background in accounting. Until 15 years ago taxes were my sideline, not my main gig, being the CFO for a local corporation was my main gig. Inventory was a major part of my prior work history and a major part of my pre and post grad classes.

 

[Taxing Matters]

By way of reference I'm an EA and waiting on results of the USTCP exam, without a true accounting background.

Good luck on the exam.

 

[davew9128]

Good luck on the exam.

Thanks, hoping for results in about a month.