what the code and regulations say about inventory
irc 471
(a)General rule
Whenever in the opinion of the Secretary the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.
(c)Exemption for certain small businesses
(1)In general
In the case of any taxpayer which meets the gross receipts test of section 448(c) for any taxable year— (you do if your sales are under $30 million)
(A)subsection (a) shall not apply with respect to such taxpayer for such taxable year, and
(B)the taxpayer’s method of accounting for inventory for such taxable year shall not be treated as failing to clearly reflect income if such method either - ( you don't have to account for inventory if you meet either of these tests)
(i)treats inventory as non-incidental materials and supplies (NIMS), or (but read the regs below) which changed things for NIMS) { this is X for purposes of X or Y below)
(ii)conforms to such taxpayer’s method of accounting reflected in an applicable financial statement of the taxpayer with respect to such taxable year or, if the taxpayer does not have any applicable financial statement (AFS)that's in IRC 451(b)(3) with respect to such taxable year, the books and records of the taxpayer prepared in accordance with the taxpayer’s accounting procedures. (if your books and records expense inventory, then you can do the same for tax purposes) (this is Y for purposes of X or Y below)
so what is an AFS
iirc 451 (b)(3)
(3)Applicable financial statement
For purposes of this subsection, the term “applicable financial statement” means—
(A)a financial statement which is certified as being prepared in accordance with generally accepted accounting principles and which is—
(i)a 10–K (or successor form), or annual statement to shareholders, required to be filed by the taxpayer with the United States Securities and Exchange Commission,
(ii)an audited financial statement of the taxpayer which is used for—
(I)credit purposes,
(II)reporting to shareholders, partners, or other proprietors, or to beneficiaries, or
(III)any other substantial nontax purpose,
but only if there is no statement of the taxpayer described in clause (i), or
(iii)filed by the taxpayer with any other Federal agency for purposes other than Federal tax purposes, but only if there is no statement of the taxpayer described in clause (i) or (ii)
(My guess is you don't have an AFS) so your back to X or Y above or maybe its clearer
under reg 1,471-1(b)
(3) Methods of accounting under the small business taxpayer exemption. A taxpayer eligible to use, and that chooses to use, the exemption described in paragraph (b) (sales under $30 million) of this section may account for its inventory by either:
(i) Using a method that treats its inventory as non-incidental materials and supplies (section 471(c) NIMS inventory method), as described in paragraph (b)(4) of this section; or
(ii) Using the method for each item that is reflected in the taxpayer's applicable financial statement (AFS) (AFS section 471(c) inventory method); or, if the taxpayer does not have an AFS for the taxable year, the books and records of the taxpayer prepared in accordance with the taxpayer's accounting procedures, (non-AFS section 471(c) inventory method).
(4) Inventory treated as non-incidental materials and supplies—(i) In general. The costs of inventory treated as non-incidental materials and supplies are recovered through cost of goods sold only in the taxable year in which the inventory is used or consumed in the taxpayer's business, or in the taxable year in which the taxpayer pays for or incurs the cost of the inventory, whichever is later. Inventory treated as non-incidental materials and supplies is used or consumed in the taxpayer's business in the taxable year in which the taxpayer provides the inventory to its customer. The costs of inventory are treated as non-incidental materials and supplies under this paragraph (b)(4) are not eligible for the de minimis safe harbor election under § 1.263(a)-1(f)(2). Section 263 complicates things if you account for inventory because it requires the capitalization as part of the cost of inventory certain direct and indirect costs
If you must or decide to account for inventories,H ere's what I suggest. For everything except your business, you can report on the cash basis. For inventory and sales you must use the accrual method. Under the accrual method, sales are reported in the year made even if the proceeds are not collected until the following year and if never collected you get a bad-debt write-off. Purcases are reported in the year they enter into your inventory, even if not paid for until the following year. in effect the cost of the sale and the sale are reported in the same year.
that leaves valuing ending inventory for which there are many acceptable methods
1) cost - the same as what you paid based on the first in is the first sold (FIFO). What's in ending inventory is priced using the last purchases.
2) lower of cost or market - using the FiFO method above. each item is valued at cost and year-end market value. the total cost is compared to the total market value and the lower amount is used.
3) average cost - you sum up the cost of purchase for each different item and divide by the number purchased. you then multiply the quantity of each item in ending inventory by the average cost
4) specific identificationc
any change from a method used in the prior year requires filing form 3115 for a change in accounting method.
