Many folks do not understand how inventory works. So I'll do my best to explain it as simple as possible, in as few words as possible. While it's simple once you understand it, this can be rather difficult to explain. Capitalization is for emphasis on importance, and also because there are those who just can't seem to "get it" unless you beat it into them with a ball peen hammer. Since this is a public forum and many folks read these threads, those who do read our thread and have a hard time "getting it", can consider the capitals to be that hammer. 🙂
Also understand that what you pay for your inventory is not a deductible expenses until the tax year you actually sell that inventory. So if you purchased $1000 of inventory 10 years ago in 2007, and you sell that inventory ten years later in 2017, it's cost t hat you paid in 2007 is deductible in 2017 since that's the year you sold it.
So here's how inventory works on your taxes.
- Beginning of Year (BOY) Inventory - What *YOU* paid for the inventory in your physical possession on Jan 1 of the tax year. It flat out *DOES* *NOT* *MATTER* in what year that inventory was purchased. If this is your first year dealing with inventory, then your BOY Inventory balance *MUST* be zero. No if's, ands or buts about it. ZERO.
- End of Year (EOY) Inventory - What *YOU* paid for the inventory in your physical possession on Dec 31 of the tax year.
-Cost of Goods Sold (COGS) - What *YOU* paid for the inventory that you actually sold during the tax year. It flat out does not matter in what year you paid for that inventory either. So here's how this works with the math.
BOY Inventory - $0
COGS - $5000
EOY Inventory - $1000
The above indicates that you started the tax year with no inventory, and then you purchased $6000 of inventory in that same tax year. You also sold $5000 of that inventory during the tax year, leaving you a balance of $1000 at the end of the year.
BOY Inventory $1000
COGS - $2000
EOY Inventory - $4000
The above shows I started the year with $1000 of inventory. It also shows that I purchased an additional $5000 of inventory bringing the total inventory in my possession during the tax year to $6000. THen I sold $2000 worth of inventory leaving me with $4000 of inventory at the end of the year.
One thing that is important here too if you don't want to be audited on this. The BOY inventory of a tax year *MUST* match the EOY inventory of the previous year. This is why in the first year you are dealing with inventory, your BOY inventory has to be ZERO. Since it's your first year dealing with inventory, there is no way on earth your business "ended last year" with more than zero.
