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farabundo1923
Level 1

Cost of Goods Sold with consignment inventory

I'm trying to calculate my Cost of Goods Sold and have a few questions.

 

1. My business operates on consignment (consignors give us products to sell in the shop, and we pay them once they sell), in addition to a small percentage of inventory being purchased wholesale. In order to calculate my "Beginning inventory" and "Ending inventory," do I include only the wholesale items? I've read on an IRS document to exclude "items on consignment," but have read other conflicting things.

 

2. Seeing as this is the first year the business is in operation, the "Beginning inventory" is nearly zero, and the "Ending inventory" much higher, resulting in a negative number for Cost of Goods Sold (there aren't that many "Purchases" required for us to get the goods). This seems to ignore a large amount of inventory we obtained throughout the year, but sold (meaning it's not in either category). Would these items obtained in the middle of the year go under "Purchases"?

 

All and any help is appreciated. Thanks!

1 Best answer

Accepted Solutions
ColeenD3
Employee Tax Expert

Cost of Goods Sold with consignment inventory

Please see this answer from PatriciaV:

 

Yes, you may categorize the consignment payments as "Commissions Expense" under Business Expenses.

In general, Inventory accounts for goods available for sale that have an associated cost to manufacture or acquire. If you do not pay for the consigned inventory in your store, it has no associated cost. For this reason, you would not include consigned inventory on your business return. (See IRS Rules here.)

 

To make things easy on yourself, you can avoid the inventory question all together.

 

If you use cash method and your total average income for the last 3 years was less than $1,000,000 per year, you don't need to use the cost of goods sold section at all.

Instead, you can just write off your merchandise under supplies or miscellaneous expenses when you purchase it. In this case, your merchandise purchase in 2019 would be fully written off then as a business expense. 

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5 Replies
ColeenD3
Employee Tax Expert

Cost of Goods Sold with consignment inventory

Please see this answer from PatriciaV:

 

Yes, you may categorize the consignment payments as "Commissions Expense" under Business Expenses.

In general, Inventory accounts for goods available for sale that have an associated cost to manufacture or acquire. If you do not pay for the consigned inventory in your store, it has no associated cost. For this reason, you would not include consigned inventory on your business return. (See IRS Rules here.)

 

To make things easy on yourself, you can avoid the inventory question all together.

 

If you use cash method and your total average income for the last 3 years was less than $1,000,000 per year, you don't need to use the cost of goods sold section at all.

Instead, you can just write off your merchandise under supplies or miscellaneous expenses when you purchase it. In this case, your merchandise purchase in 2019 would be fully written off then as a business expense. 

**Say "Thanks" by clicking the thumb icon in a post
**Mark the post that answers your question by clicking on "Mark as Best Answer"

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Carl
Level 15

Cost of Goods Sold with consignment inventory

1. My business operates on consignment (consignors give us products to sell in the shop, and we pay them once they sell), in addition to a small percentage of inventory being purchased wholesale. In order to calculate my "Beginning inventory" and "Ending inventory," do I include only the wholesale items?

Items you sell on consignment are not yours. They never were, are not now and never will be. At no time do you pay a purchase price for a consignment item. If the item sells, you keep your percentage of the sale price as business income and the original owner of the consignment item you sold gets the rest. If the consignment item does not sell, then the owner of that item just takes it back into their possession. So at no time do you have any ownership rights to a consignment item. Under no circumstances do you include it in the inventory COGS section for any reason.

I've read on an IRS document to exclude "items on consignment," but have read other conflicting things.

There is no conflict here. The IRS publication is the final authority, and the "only" authority. What others say (including me) hold absolutely no weight what-so-ever if it conflicts with what is contained in in IRS publication.  The IRS publication is "the bible" on this stuff. No exceptions.

2. Seeing as this is the first year the business is in operation, the "Beginning inventory" is nearly zero,

No. It's not "nearly" zero. It "is" zero. For your first year of business or first year of deal with inventory, your BOY Inventory balance *MUST* be zero, and there are no exceptions. If flat out does not matter in what tax year you purchased or acquired that inventory either.

One reason for this is because your BOY Inventory balance absolutely must match exactly your prior year's EOY Inventory Balance. Since 2019 was your first year of business and the business did not even exist in 2018, there is no way possible that your business had an inventory balance greater than ZERO in 2018. So your 2019 BOY Inventory Balance has to be zero, with no exceptions.

For each tax year you deal with inventory, if your BOY Inventory balance doesn't match the prior year's EOY balance, you'll have some 'splainin' to do to the IRS, and there is no way possible you're going to "explain" that difference.

and the "Ending inventory" much higher, resulting in a negative number for Cost of Goods Sold (there aren't that many "Purchases" required for us to get the goods). This seems to ignore a large amount of inventory we obtained throughout the year, but sold (meaning it's not in either category). Would these items obtained in the middle of the year go under "Purchases"?

Apparently you don't understand how COGS works. Don't worry, it's not like you learn this stuff through osmosis and for a first timer it can't take a bit to wrap your head around it. In my opinion, the way the IRS requires you to report it on your taxes is what I refer to as "going around your elbow to get to your thumb". But once you understand it, it's simple. So here goes.

Understand that what you pay for inventory is not deductible until the tax year you sell it. Period. It does not matter if you purhcased that inventory 50 years ago. You can't deduct what you paid for it, until the tax year you actually sell it. Here's two examples, with example 1 showing the first year, and example 2 showing the 2nd hear.

BOY Inventory Balance = $0 This is what 'YOU" paid for the inventory in your physical possession on Jan 1 of the tax year. This amount *MUST* match your prior year's EOY balance. So if this is your first year dealing with inventory, the BOY balance must be zero with no exceptions, regardless of what tax year you actually purchased the inventory.

Cost of Goods Sold (COGS) - $5000 This is what *YOU* paid for the inventory that you actually sold in the tax year. It does not matter in what tax year you paid for this sold inventory either.

EOY Inventory Balance - $6000  This is what "YOU" paid for the inventory in your physical possession on Dec 31 of the tax year.

The above year 1 example indicates that you started the tax year with zero inventory. It also indicates that throughout the year you purchased a total of $11,000 in inventory. During the same tax year you sold $5000 of that inventory, leaving you with $6000 of inventory in your physical possession on Dec 31 of the tax year.

The $5000 of inventory you sold is the amount that will be deducted from your gross business income so you don't pay taxes on it.

Example #2 (2nd year of business)

BOY Inventory - $6000 Take special note that this matches exactly, the prior year's EOY inventory balance. It "must" match. No exceptions.

Cost of Goods Sold (COGS) - $3000

EOY Inventory - $12,000 This is what "you" paid for the inventory in your physical possession on Dec 31 of the 2nd tax year. Again, it doesn't matter in what year you purchased that inventory either.

The above indicates you started your 2nd year of business with$6000 of inventory. Then throughout the year you purchased an additional $9000 of inventory bringing your inventory total for the year to $$15,000. Then out of that $15,000 of inventory you sold $3000 of that inventory leaving you with an EOY Inventory balance of $12,000.

The $3000 of inventory you sold in this 2nd year will be deducted from your gross business income so you don't pay taxes on it.

I think the above should help you get things straight now. If not, just let me know where additional clarification may be needed.

 

farabundo1923
Level 1

Cost of Goods Sold with consignment inventory

Thanks for the response. We use the cash method and don't make that much money. Could I confirm what you're saying: we don't need fill out the Cost of goods sold (Line 2 on the F-1065, which gets put on the 1125-A) at all?

 

Thanks for your time and help.

ColeenD3
Employee Tax Expert

Cost of Goods Sold with consignment inventory

No, you are not required to use COGS. 

 

Filers of Form 1120, 1120-C, 1120-F, 1120S, 1065, or 1065-B complete and attach this form if they report a deduction for cost of goods sold.

 

From Form 1125-A:

 

What's New Small business taxpayers.

For tax years beginning after December 31, 2017, the following apply. A small business taxpayer (defined below), may use a method of accounting for inventories that either:

  • (1) treats inventories as nonincidental materials and supplies, or
  • (2) conforms to the taxpayer's financial accounting treatment of inventories.
  •  A small business taxpayer is not required to capitalize costs under section 263A
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Carl
Level 15

Cost of Goods Sold with consignment inventory

Could I confirm what you're saying: we don't need fill out the Cost of goods sold

True. Since your business does less than $1M of gross income a year, COGS is not required. But you can use COGS if you chose to do so. If you don't use COGS then you can enter what you pay for inventory as a supplies expense.

I myself use COGS for the sole reason that it allows me to more easily and simply keep track of inventory with each passing year. This way, I report my inventory on a first in/first out basis. Remember, since costs never stay the same what I paid for inventory purchased in 2017/2018 will most likely not be the same price I paid for that same inventory in 2019.

 

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